TAXATION OF SHARES AND

SECURITIES

AT WIRC
ON 23rd January, 2010.
CA. Nihar Jambusaria
• (1) Dividend & Interest Income
• (2) Provisions to Prevent Possible Tax
Avoidance
• (3) Capital Gains
• (4) Business Income including Speculation
Income
• (5) Issues Related to Stock Brokers
DIVIDEND AND INTEREST INCOME

• Dividend exempt u/s. 10(34) :

• Income from units exempt u/s. 10(35)

 MEASURES TO CHECK TAX
AVOIDANCE/EVASION
• Dividend stripping S. 94(7)

Where –

(a) any person buys or acquires any securities or unit

within a period of three months prior to the record date;

(b) such person sells or transfers –

such securities within a period of three months

after such date; or

such unit within a period of nine months after
such date;
MEASURES TO CHECK TAX
AVOIDANCE/EVASION (Contd)
(c) the dividend income on such securities or unit received or
receivable by such person is exempt,

then, the loss, if any, arising to him on account of such

purchase and sale of securities or unit, to the extent such
loss does not exceed the amount of dividend or income
received or receivable on such securities or unit, shall be
ignored for the purposes of computing his income
chargeable to tax.

S. 94(7) cannot be applied from retrospective effect.

Wallfort Shares & Stock Brokers Pvt. Ltd. v.

ITO & Ors. 96 ITD 1 (Mum.) (TM).
MEASURES TO CHECK TAX
AVOIDANCE/EVASION (Contd)
• Bonus / right stripping S. 94(8)

Where –

(a)any person buys or acquires any units within a period

of three months prior to the record date;

(b)such person is allotted additional units without any

payment on the basis of holding of such units on such
date;
MEASURES TO CHECK TAX
AVOIDANCE/EVASION (Contd)
c) such person sells or transfers all or any of the units
referred to in clause (a) within a period of nine months
after such date, while continuing to hold all or any of
the additional units referred to in clause (b),

then, the loss, if any, arising to him on account of such

purchase and sale of all or any of such units shall be
ignored for the purposes of computing his income
chargeable to tax and notwithstanding anything
contained in any other provision of this Act, the amount
of loss so ignored shall be deemed to be the cost of
purchase or acquisition of such additional units referred
to in clause (b) as are held by him on the date of such
sale or transfer.
CAPITAL GAINS

• Short-term Capital Gain :

(a) On listed securities transferred after 30.09.2004 on

which S.T.T. is paid - Taxable at 10%, 15% w.e.f. A. Y.
2009-10.

(b) On any other security transferred after 30.09.2004 -

Taxable at normal rate.
CAPITAL GAINS (Contd.)
• Long Term Capital Gain :

(a) On eligible equity shares purchased on or after

01.03.03 and before 01.03.04 exempt u/s. 10(36).

(b) On equity shares or units of an equity oriented fund

arising after 30.09.04 on which S.T.T. is paid – exempt
u/s. 10(38).
BUSINESS INCOME

• Where equity shares or units in an equity oriented fund

are held as stock in trade and are sold after 1-4-2008 on
which S.T.T. is paid – taxable at normal rate and S.T.T.
paid is allowable as deduction U/S.36(1)(xv) in
computing income under this head.
BUSINESS INCOME (contd.)
• Issues –

1. Where a large number of transactions of purchase and sales of

shares and securities of different companies are entered into
during P. Y., whether the gain can be declared as short term or
long term capital gain or should it be declared under the head
income from business or profession.

Consider the decisions –

o Smt. Neerja Birla v. ACIT 66 ITD 148 (Mum.) and

o Arjun Kapoor 70 ITD 161 (Del.)
o Janak Rangwala vs. ACIT 11 SOT 627 (Mum.)
o Circular No.4/2007 dt. 15-6-2007.
• The following factors would be relevant in determining
whether transactions for purchase & sale of shares &
securities are in the nature of business or investment?

(1) Motive
(2) Number of transactions
(3) Relation with other activities
(4) Source of investment
(5) Resources employed
• If share transactions are treated as business, the
following expenses are allowable as deduction-

(1) Interest on borrowed capital

(2) Brokerage, service tax, stamp duty
(3) Penalties, bad delivery charges, auction charges
(4) Demat account charges
(5) Portfolio Management & advisory fees
BUSINESS INCOME (contd.)

• Trading in Derivatives :

• An eligible transaction in respect of trading in derivatives

shall not be deemed to be a speculative transaction
w.e.f. 01.04.06 by virtue of addition of clause (d) to S.
43(5).
CAPITAL GAINS
• Conversion of capital assets into stock in trade –

• Issues –

• Any care is required to be taken before converting

shares / securities into stock in trade ?

• Whether an assessee can hold some shares and

securities as stock in trade and some shares and
securities as investment.

o Century Builder – 5694/Mum./2000/dt. 30.07.02

o Arjun Kapoor 70ITD161(Del)
o Circular No. 4/2007 dt. 15-6-2007
CAPITAL GAINS (contd.)

Tax Treatment of Deep Discount Bonds:

Consider circular No. 2 of 2002 dated 15.02.2002

CERTAIN JUDGEMENTS

1. Shares obtained in family settlement – Family

settlement is analogous to partition of H.U.F.
Therefore, S. 49(1)(i) shall apply for determining the
cost of acquisition of shares under family settlement.

Shanti Chandran 241 ITR 371 (Mad.)

CERTAIN JUDGEMENTS (contd.)

• 2. Bad investments written off would not give rise to

capital loss.
R.C. Mudliar 240 ITR 552 (Mad.)
3. Where business loss arises due to valuation of closing
stock at cost or market price whichever is less and
there was no purchase and sale of shares during the
P.Y., Explanation to S. 73 does not apply.

Nirvan Holding Pvt. Ltd. BCA-399 JULY 2003, SMC,

MUM Sun Dist. & Mining Co. 68 Taxman 223.
Mumbai High Court held in Prasad Agents Pvt. Ltd. V.
ITO [2009 TIOL-164-HC-MUM] that share valuation
loss is covered by Explanation to S.73.
CERTAIN JUDGEMENTS (contd.)

4. Where shares / securities are acquired by any mode u/s.

49(1), indexation shall be allowed from the P. Y. of
acquisition of the previous owner.

o Pushpa Sophat v. ITO 81 ITD 1 (Chd.)

o Meera Khera February 2004 BCA Journal.
o Contrary- Kishor Kanoongo Mum. Trib.
o DCIT v. Manjula J. Shah dt.16th October, 2009.
CERTAIN JUDGEMENTS (contd.)

5. Indexation is allowable on L.T.C.G. on transfer of

MEP’91 and MEP’92 – refer S. 45(6).

K. B. Shah 77 TTJ 30 (Mum.)

6. Transfer of investments is not hit by Explanation to S.

73.

Mysore Rolling Mills Pvt. Ltd. 195 ITR 405 (Kar.)

SPECULATION BUSINESS
A transaction which is not periodically or ultimately settled by
delivery or transfer of the contracted goods is a ‘speculative
transaction’ as defined by S. 43(5) of the Income-tax Act.
No exception is made in that section for shares and stocks –
in fact, s. 43(5) specifically includes stocks and shares, and
hence the provisions of S. 43(5) equally apply to dealing in
shares and stocks. Under the normal understanding, a
speculative transaction is one where there is no intention to
take or give delivery.
However, under the income-tax law, the intention of the
purchaser or seller to take or give delivery of the shares is
immaterial for determining a speculative transaction. What is
material is whether delivery or transfer has
actually taken place or not.
SPECULATION BUSINESS (Contd)
Explanation 2 to s.28 reads as under :

‘Where speculative transactions carried on by an assessee

are of such a nature as to constitute a business, the
business (hereinafter referred to as “speculation business”)
shall be deemed to be distinct and separate from any other
business’.
SPECULATION BUSINESS (Contd)
S. 43(5) provides for certain exceptions. The following
transactions concerning share and stocks are not construed as
speculative transactions by virtue of the proviso to S. 43(5) :

a contract in respect of stocks and shares entered by a dealer

or investor to guard against loss in his holdings of stocks and
shares through price fluctuations (commonly referred to as
hedging transactions).

a contract entered into by a member of a forward market or a

stock exchange in the course of any transaction in the nature
of jobbing or arbitrage to guard against loss which may arise in
the ordinary course of his business as such member.

An eligible transaction of dealing in derivatives,

with effect from A.Y. 2006-07.
• Explanation to S.73-
Where any part of the business of a
company other than a company
whose gross total income consists
mainly of income chargeable under
the heads Interest on Sec., Inc. from
House Prop., Capital Gains and Inc.
from Other Sources or a company
the principal business is banking or
granting of loans and advances
• Consists in the purchase and sale of
shares of other companies, such
company shall for the purposes of
this section, be deemed to be
carrying on a speculation business to
the extent to which the business
consists of the purchase and sale of
shares.
• Issues relating to Expln. to S.73-

(1) Applicability to shares held as investments-

• Mysore Rolling Mills Pvt. Ltd. 195ITR 404(kar)
• Trade Team Pvt. Ltd. 54 ITD 36(Bom)

(2) Share broking-Whether business of purchase & sale of

shares?

• SRJ Securities Ltd. v ACIT 81 TTJ 484 (Del)

• DCIT v Frontline Capital Services Ltd. 96 TTJ 201
(Del)
(3) Applicability to securities other than shares

• Appollo Tyres Ltd. 255 ITR 273 (S.C.)

(4) Loss due to stock valuation not regarded as speculation loss

• Nirvan Holding Pvt. Ltd. 35 BCAJ 399 (Mum)

• Contrary view-Prudential Constn. Co. Pvt. Ltd. 75 ITD 338 (Hyd.)
• Associated Capital Markets Pvt. Ltd. ITA No11-3-4 & 3057
Mum.2001 dt 31-3-2003
• Now resolved by Mum. H.C. decision in Prasad Agents- Contrary
view upheld.
(5) Whether the Expln. Applies to arbitrage, hedging,etc.
excluded from the meaning of speculation u/s. 43(5)?

• Rohini Capital Services Ltd. v DCIT 92 ITD 317 (Del)

(6) Settlement for breach of contract is not a speculative

transaction.

• Bhandari Rajmal Kushalraj v ITO 96 ITR 401

Issues relating to Share Brokers

(1) Determination of Turnover

(2) Allocation of expenses to speculaive & other

transactions when the assessee is a company.

(3) Allocation of expenses to Dividend Income-S.14A.

• Conversion of Stock into Capital Asset

• Whether conversion of shares held as stock in trade into

capital asset would attract any tax.
• What will be the cost of acquisition of such shares – cost
or market value?
Disallowance of Expenses u/s. 14A

History

(a) Before the introduction of S. 14A-

• CIT v. Indian Bank Ltd. 56 ITR 77 (SC)

• CIT v. Maharashtra Sugar Mills Ltd. 82 ITR 452 (SC)
• Rajasthan Warehousing Corporation v. CIT 242 ITR
450 (SC)
(b) After introduction of S. 14A-

Rule 8D-

Direct Expenditure plus

Interest AxB plus

C

½% of average investment

• ITO v. Daga Capital Management Pvt. Ltd. 26 SOT

603(Mum) (Spec. Bench)

• ACIT v. Indexport Ltd.- Mum. Trib.

(1) Share & Stock Broker-

Dividend Income: Rs. 12,50,000/-

Expenditure in relation to dividend income: Rs. 15,000/-

• A. O. wants to apply Rule 8D.

(2) Civil Contractor-

• Income from civil construction taxable u/s. 44AD

• Dividend Income Rs. 12,00,000
• Disallowance u/R.- 8D.
(3) A co acquired investments out of its own funds in 2000-
Cost Rs.5 Crores.

• Dividend Income Rs. 25,00,000

• Obtained loans in 2002 for other activities.
• A. O. wants to disallow interest as per Rule 8D from
other taxable income.
(4) A trader in shares has a profit of Rs. 15,00,000 from
share trading and Rs. 1,50,000 from dividend.

• Allocation of direct and indirect expenses.

• Can one contend that no disallowance can be made as
from the same activity assessee has earned taxable
income.
CIRCULAR NO. 4/2007, DATED 15-6-2007
Distinction between shares held as stock-in-trade and shares held
as investment - tests for such a distinction

• The Income Tax Act, 1961 makes a distinction between a capital

asset and a trading asset.

• Capital asset is defined in Section 2(14) of the Act. Long-term

capital assets and gains are dealt with under Section 2(29A) and
Section 2(29B). Short-term capital assets and gains are dealt with
under Section 2(42A) and Section 2(42B).

• Trading asset is dealt with under Section 28 of the Act.

CIRCULAR NO. 4/2007, DATED 15-6-2007
4. The Central Board of Direct Taxes (CBDT) through Instruction
No.1827 dated August 31, 1989 had brought to the notice of the
assessing officers that there is a distinction between shares held as
investment (capital asset) and shares held as stock-in-trade
(trading asset). In the light of a number of judicial decisions
pronounced after the issue of the above instructions, it is proposed
to update the above instructions for the information of assessees as
well as for guidance of the assessing officers.

5. In the case of Commissioner of Income Tax (Central), Calcutta Vs

Associated Industrial Development Company (P) Ltd (82 ITR 586),
the Supreme Court observed that:

• Whether a particular holding of shares is by way of investment

or forms part of the stock-in-trade is a matter which is within the
knowledge of the assessee who holds the shares and it should,
in normal circumstances, be in a position to produce evidence
from its records as to whether it has maintained any distinction
between those shares which are its stock-in-trade and those
which are held by way of investment.
CIRCULAR NO. 4/2007, DATED 15-6-2007
6. In the case of Commissioner of Income Tax, Bombay Vs H. Holck
Larsen (160 ITR 67), the Supreme Court observed:

• The High Court, in our opinion, made a mistake in observing

whether transactions of sale and purchase of shares were trading
transactions or whether these were in the nature of investment
was a question of law. This was a mixed question of law and fact.

7. The principles laid down by the Supreme Court in the above two cases
afford adequate guidance to the assessing officers.

8. The Authority for Advance Rulings (AAR) (288 ITR 641), referring to
the decisions of the Supreme Court in several cases, has culled out
the following principles :-
CIRCULAR NO. 4/2007, DATED 15-6-2007
(i) Where a company purchases and sells shares, it must be shown
that they were held as stock-in-trade and that existence of the
power to purchase and sell shares in the memorandum of
association is not decisive of the nature of transaction;

(ii) the substantial nature of transactions, the manner of maintaining

books of accounts, the magnitude of purchases and sales and the
ratio between purchases and sales and the holding would furnish
a good guide to determine the nature of transactions;

(iii) ordinarily the purchase and sale of shares with the motive of
earning a profit, would result in the transaction being in the nature
of trade/adventure in the nature of trade; but where the object of
the investment in shares of a company is to derive income by way
of dividend etc. then the profits accruing by change in such
investment (by sale of shares) will yield capital gain and not
revenue receipt.
CIRCULAR NO. 4/2007, DATED 15-6-2007
9. Dealing with the above three principles, the AAR has observed in
the case of Fidelity group as under:-

• We shall revert to the aforementioned principles. The first principle

requires us to ascertain whether the purchase of shares by a FII in
exercise of the power in the memorandum of association/trust deed
was as stock in-trade as the mere existence of the power to
purchase and sell shares will not by itself be decisive of the nature of
transaction. We have to verify as to how the shares were valued/held
in the books of account i.e. whether they were valued as stock-in-
trade at the end of the financial year for the purpose of arriving at
business income or held as investment in capital assets.

• The second principle furnishes a guide for determining the nature of

transaction by verifying whether there are substantial transactions,
their magnitude, etc., maintenance of books of account and finding
the ratio between purchases and sales.
CIRCULAR NO. 4/2007, DATED 15-6-2007
• It will not be out of place to mention that regulation 18 of the SEBI
Regulations enjoins upon every FII to keep and maintain books of
account containing true and fair accounts relating to remittance of
initial corpus of buying and selling and realizing capital gains on
investments and accounts of remittance to India for investment in
India and realizing capital gains on investment from such
remittances.

• The third principle suggests that ordinarily purchases and sales of

shares with the motive of realizing profit would lead to inference of
trade/adventure in the nature of trade; where the object of the
investment in shares of companies is to derive income by way of
dividends etc., the transactions of purchases and sales of shares
would yield capital gains and not business profits.
CIRCULAR NO. 4/2007, DATED 15-6-2007
10.CBDT also wishes to emphasise that it is possible for a tax payer to
have two portfolios, i.e., an investment portfolio comprising of
securities which are to be treated as capital assets and a trading
portfolio comprising of stock-in-trade which are to be treated as trading
assets. Where an assessee has two portfolios, the assessee may have
income under both heads i.e., capital gains as well as business
income.

11.Assessing officers are advised that the above principles should guide
them in determining whether, in a given case, the shares are held by
the assessee as investment (and therefore giving rise to capital gains)
or as stock-in-trade (and therefore giving rise to business profits). The
assessing officers are further advised that no single principle would be
decisive and the total effect of all the principles should be considered
to determine whether, in a given case, the shares are held by the
assessee as investment or stock-in-trade.

12.These instructions shall supplement the earlier Instruction

no. 1827 dated August 31, 1989.
 Nihar Jambusaria
jnihar@rediffmail.com
Nihar.jambusaria@bdoharibhakti.co.in